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Why Companies Aren’t Investing Their Tax Cut Windfalls

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By Michael Rainey

May 24, 2018

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We’re five months into the new business tax system in the U.S., and while companies are clearly pleased with the drop in the top rate to 21 percent, they’re not quite sure what to do with the cash that’s piling up, says Howard Gleckman of the Tax Policy Institute.

One big problem is uncertainty surrounding some of the new rules, especially as they relate to the taxation of international profits. Reflecting on recent discussions he had at the National Tax Association’s annual meeting, Gleckman says that “large multinational businesses—and their tax advisers—do not yet understand the new law, and thus are reluctant to commit to major investments.”

The old tax law had many problems, Gleckman writes, but the flawed system at least provided the certainty that many businesses say they need to plan new capital spending. Numerous critics have pointed out that the promised surge in domestic investment as a result of the corporate tax cut has yet to materialize, and Gleckman thinks that uncertainty over how the new rules will work in practice and the possibility that they may see substantial adjustments in the near future are leading companies to sit on the cash or simply return it to shareholders through dividends and buybacks. “[F]irms often repurchase shares when they don’t know what else to do with cash,” Gleckman notes.

The uncertainty is attached to some of the major provisions of the new tax law that affect U.S.-based multinationals. Key components include:

* the Global Intangible Low Tax Income (GILTI), which creates complicated new rules for taxing the incomes of foreign affiliates

* the Base Erosion Alternative Minimum Tax (BEAT), designed to ensure that U.S. companies can’t use transactions like royalty and interest payments to shift all of their profits overseas (for a sense of how complicated BEAT is, and the lively debate that has already sprung up around it, see this analysis by Martin Sullivan of Tax Notes)

* a tax deduction for Foreign Direct Intangible Income (FDII), which relates to the connection between foreign income and domestically held intangible assets, such as drug patents

* the one-time tax on profits held overseas, to be collected over the next eight years at a rate of 15.5 percent on cash and other liquid assets and 8 percent on non-cash assets – but lawmakers never clearly defined what counts as cash.

There are plenty of possible reasons that companies aren’t making big investments with their tax windfalls, Gleckman says, including a sense that the economy is near the peak of its cycle, a lack of good new projects to invest in and continued weakness in overall demand. But the uncertainty surrounding the new, hastily written tax rules on foreign profits probably hasn’t helped.